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Rising US Automobile Debt Foreshadows an Impending Credit Crisis

Euromonitor data shows that US consumer expenditure on vehicles grew by 36% in real terms between 2009 and 2016 while disposable income grew by just 15%. The outstanding balance of consumer auto loans also increased by 36% in real terms between 2009 and 2016 while the outstanding balance of consumer loans as a whole decreased by 7%. JATO data shows a decrease in the number of passenger cars on the road in the US between 2009 and 2016, which means that the average auto debt per passenger car in circulation rose from $5,700 to $8,200 in real terms between 2009 and 2016 – a 44% increase.

Sources: JATO, Euromonitor International

Note: Passenger vehicles in circulation and auto debt figures include two wheelers. Two wheelers comprise approximately 5% of vehicles on the road and are not expected to significantly impact overall trends in the passenger vehicle market. Commercial vehicles (e.g., fleet sales) are excluded.

Decreasing Numbers of Passenger Cars on the Road but Steady Sales: How?

Despite automakers touting better quality vehicles that last longer, the decreasing number of passenger cars on the road – combined with steady new cars sales – suggests that automakers and lenders have grown increasingly aggressive to drive sales. Morgan Stanley reports that the percentage of subprime auto loan asset backed securities categorized as “deep subprime” (the riskiest category) has risen from 5.1% in 2010 to 32.5% today. Auto lenders, burned by a credit crunch during the recession, have gradually relaxed their loan qualification requirements as the US economy recovered. Moody’s reports that auto lenders have allowed record levels of negative equity for both new and used vehicle purchases, which means that consumers’ outstanding debt from their previous vehicles is snowballing instead of decreasing or even remaining steady when they acquire a new (or used) car.

While automakers may benefit from increased sales in the short term, this vicious cycle “trade-in treadmill,” as coined by Moody’s, is beginning to show signs of faltering: stagnating new car sales, swelling inventories, and declining used car prices. Per the Automotive News Data Center, the US seasonally adjusted annual rate (SAAR) of car sales has remained nearly constant at 18 million vehicles sold per month since May 2015. In Febraury 2017, new vehicle inventories reached their highest level since at least January 2005. NADA, the National Automobile Dealers Association, noted the biggest drop in used car prices in February 2017 since November 2008 as more vehicles come off leases.

Still Time to Adapt

The good news for auto companies and lenders is that the overall rate of auto loan defaults is still relatively stable, which means that there is an opportunity to course-correct before a credit crunch is inevitable. The S&P/Experian Auto Default Index is unchanged year-over-year and less than half of what it was in the depths of the recession.

Intelligent automakers and lenders must increase their conservatism now in order to protect themselves against a future car credit bubble. Automakers, whose profitability depends largely on volume, should promote cheaper vehicles that consumers can actually afford by marketing less feature-laden vehicles. Lenders, who have increasingly offered auto loans with lower interest rates but with long terms that often exceed the amount of time that consumers own their vehicles, should realize that they are creating a negative equity bubble that will hurt their profitability in the not-too-distant future.

Fewer subprime and long-term auto loans will result in slower sales in the short term but steadier returns in the medium and long terms. If automakers continue production at their current levels and lenders continue offering long-term loans to risky demographics, the negative impact will be two-fold:

Used car prices will continue to decline as oversupply continues from vehicles coming off-lease. Consumers who have the means to purchase a new car may opt to purchase a slightly used, off-lease vehicle for a significant cost savings, eroding demand for new cars. If a credit crunch happens, demand for used cars will rise at the expense of new cars, as consumers who are stuck in negative equity car loans will be unable to afford a new vehicle.

OEMs and auto loan companies will look even more to the margins of qualified customers to drive sales. Risky lending increases the risks of auto loan defaults and makes OEMs and lenders more susceptible to changing macroeconomic conditions. A small economic downturn or even a rise in interest rates could lead to an unsustainable borrowing situation for many customers and a plunge in sales to which auto lenders and OEMs will struggle to adapt.

Eric Totaro is an Automotive Industry Analyst based out of Euromonitor International’s Chicago office. He has extensive automotive knowledge from growing up in the industry and from publishing an internally-circulated automotive briefing while working in management consulting. Eric graduated from the University of Michigan with a BBA.